The ratio of your debt to your net worth is one way of looking at your overall financial condition. It's something lenders may take into account in deciding whether to lend you money. For companies, investors and lenders often look at a related ratio of debt to equity.
You can calculate your net worth by subtracting the sum total of all of your debts from the total value of all of your assets, including investments, real estate, money in the bank, etc.
Debt and Net Worth
If you have good financial records, calculating your debt-to-net-worth ratio is relatively straightforward.
First, you need to calculate your total debt, which is simply the amount of money that you owe. This can include credit card debt, car loans, student loans, a mortgage or personal loans you may have taken from a bank or even borrowed from a friend or relative. For example, imagine that you owe $6,000 on a car and $1,000 on credit cards. Then, your total debt is the sum of those two debts, or $7,000.
Then, you need to calculate the total value of all of your assets, including real estate, vehicles, money in the bank, stocks and bonds and any valuable property you have. From this number, subtract your total debt to get your net worth. For example, if you have $15,000 in assets and $7,000 in debt, your net worth is $8,000.
If you owe more money than you have assets, your net worth can be negative. If you have no debt, your net worth is simply the sum of all of your assets.
Then, to find your debt-to-net-worth ratio, divide your total debt by your total net worth and multiply by 100 to get a percentage. For example, if your debt is $7,000 and your net worth is $8,000, your debt-to-net-worth ratio is 87.5 percent. If you don't owe anyone anything, the ratio is automatically zero.
Generally, the smaller your debt-to-net-worth ratio the better, since it means the smaller the percentage of your assets you'd have to use to cover your debts.
Debt and Equity
If you're looking at a company rather than an individual, people tend to talk about the debt-to-equity ratio, but the concept is essentially the same.
Shareholders' equity represents how much money would go to a company's shareholders after paying its debts if the company was liquidated. It's computed as the sum of the company's assets minus the sum of its liabilities, and it's often present on a company's balance sheet so you don't have to compute it directly.
The debt-to-equity ratio is the total liabilities divided by the shareholders' equity, multiplied by 100 to generate a percentage. As with personal debt-to-net-worth ratios, investors and lenders generally want to see smaller debt-to-equity ratios, since they make it more likely debts will get paid and shareholders will see some benefit as well, even in an unexpected crunch.
Generally, smaller debt-to-equity ratios are especially better in times of high interest rates, since paying debts can get expensive.
- "Entrepreneur": Debt to Equity Ratio
- "Inc."; Debt Financing
- A Refresher on Debt-to-Equity Ratio
- Debt ratio - Wikipedia
- Statement Of Stockholders’ Equity - principlesofaccounting.com
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Steven Melendez is an independent journalist with a background in technology and business. He has written for a variety of business publications including Fast Company, the Wall Street Journal, Innovation Leader and Ad Age. He was awarded the Knight Foundation scholarship to Northwestern University's Medill School of Journalism.